If you had to buy insurance, would you ask JP Morgan Chase or Wells Fargo to choose a policy for you? Probably not. And yet, the Federal Housing Finance Agency is allowing Chase, Wells and other mortgage servicing giants to insurance-shop for millions of homeowners who get saddled with absurdly over-priced coverage while the big banks walk off with kickbacks from the insurance companies.
Every mortgage holder is required to have homeowner's insurance. Sometimes the insurance lapses or gets canceled, often without the homeowner's knowledge, making it necessary for the mortgage servicer to step in and purchase a form of emergency coverage known as force-placed or lender-placed insurance. Such emergencies have become far more common since the onset of the housing crisis; and because force-placed insurance costs between two and 10 times as much as regular homeowner's insurance, it can have the perverse effect of driving families into foreclosure or making it harder for them to obtain affordable loan modifications.
Of course, the servicers like this arrangement fine, because they receive all kinds of sweeteners from insurance vendors, with the added cost built into the price of the coverage. The high premiums are the homeowners' problem – or the taxpayers', if the added expense drives a borrower into foreclosure. In that case, Fannie and Freddie are legally bound to reimburse a mortgage servicer for all costs, fair or otherwise.
Although some state regulators have begun to crack down on this practice, the Federal Housing Finance Agency – the nation's largest housing watchdog – has stymied the search for a solution.
Last November, Fannie Mae – fed up with the inflated cost of force-placed insurance – decided to purchase it directly from insurers instead of reimbursing servicers. That plan would have saved taxpayers $300 million, according to one Fannie Mae analysis. Stunningly, Fannie's regulator – the Federal Housing Finance Agency – quashed this initiative without any explanation to the public.
The FHFA continues to dither instead of playing a constructive role in bringing relief to homeowners and taxpayers. The agency has signaled that it may soon take steps to prohibit some of the kickbacks plaguing the industry and driving up prices. These practices will be difficult to police, however, and insurance sellers could find new ways to compensate servicers that are not explicitly prohibited by the FHFA.
Instead, the agency should address the fundamentally bad incentives of this marketplace by allowing the GSEs to purchase affordable force-placed insurance policies directly from insurance companies, cutting out the kickbacks. As leading consumer groups explained in a letter to the agency this week, if the FHFA works with the GSEs, the tremendous purchasing power of Fannie Mae and Freddie Mac can be used to discipline mortgage servicers and force-placed insurance providers alike.
In fact, as the agency plans for the future and builds a new platform that Fannie Mae and Freddie Mac will use to conduct most of their business, the agency should build force-placed insurance options into the system, making this insurance easier to purchase and less expensive for the GSEs.
The nation urgently needs the FHFA to act as a responsible watchdog so that homeowners can focus on keeping their homes and the GSEs can effectively support a strong housing recovery.
Sarah Edelman is a policy analyst at the Center for American Progress.